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New Colorado Law Tackles Employee Equity, Investment in Startup Cannabis Industry

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The startup-laden cannabis industry is probably just right for those who are willing to forego a few extra dollars on their paychecks for the possibility of a bigger payout later when the company grows or goes public.

Giving employees an equity stake is far from an uncommon practice in startups, and companies in turn may see it as a way to save money on payroll and encourage workers to do more.

Ownership interests in the often heavily regulated cannabis industry, however, typically come with regulatory implications by necessity.

In Colorado, which in 2012 along with Washington became the first two states to legalize recreational marijuana use, the practice of giving employees equity has been a heavily regulated process. In fact, some believe that it was too regulated, and what has resulted was not what may have been intended.

A few cannabis businesses, as a way of avoiding the regulations and cost, it seems have been giving employees equity in a sort of under-the-table manner, without proper steps or good documentation.

“Companies are giving equity, but not properly papering that,” said Christine Kessler Lamb, with Fortis Law Partners.

Her practice is largely in Colorado and is focused on employment law.

Lamb has been called in to fix a few such messes in which equity was handed out quickly, and later disputes arose over how much people owned in the business, or whether they owned anything at all.

In some cases employees filed lawsuits in which directors and officers or employment practices liability coverage may kick in, according to Lamb.

House Bill 1090, which was signed last year with effective date of November 2019 with additional work-ins effective in January, may have offered a fix.

Prior to the current framework, everyone was subject to disclosure and background requirements before owning any share of a cannabis business, and any change of ownership was subject to an application and approval process no matter how few shares were being offered.

The old framework seemed to offer good protections and require businesses to dot all the I’s and cross all the T’s, but it was onerous and costly those familiar with the regulations say.

HB 1090 changed part of the code, 2-230 Disclosure of Financial Interests in a Regulated Marijuana Business, which specified the information required to be disclosed in every initial, renewal and change of owner application.

The new law streamlines the ownership and investment framework to focus on those who control the cannabis businesses.

The threshold is now set at 10% or more ownership. Parties at and above that threshold are subject to application and suitability requirements, while the rest are referred to as “passive beneficial owners,” parities less than 10% who are also not in position to control the cannabis business.

Under the change, “indirect financial interest holders,” like financing firms, firms that lease equipment, are also exempt.

Rachel Gillette, chair of Greenspoon Marder’s cannabis law practice, believes the new law will encourage more cannabis businesses to offer equity and do so without fear of all the regulatory red tape involved.

“We probably had people that were not compliant with the regulatory environment prior to these January rule changes, and you also had people who were just not going to do it because it was too hard,” she said. “I think this is going to encourage employers to maybe offer some sort of equity program to their employees as a benefit.”

Both attorneys said they’ve seen equity become a legal matter when a company becomes successful, is acquired or it is about to go public.

Lamb pointed out numerous sticking points in the process of offering equity and then collecting on it, such as what type of equity was given, when it was given, how long an employee was with a company, how the company is structured.

“Equity means lots of different things,” Lamb said. “What we’ve been finding is there’s two different understandings of what was meant. And when there’s not documentation of what was meant, it’s a recipe for disaster.”

She’s getting a lot of business from such disasters.

“We’re starting to see people form class actions,” Lamb said. “The idea is in the right place. There’s nothing wrong with the idea (of equity). But they don’t think though what that means, or they don’t get legal advice on documenting it.”

One of the most noteworthy cases is when Colorado Springs company Folium Biosciences announced in December 2018 its plans to merge with Australis Capital Inc., a cannabis investment firm with roots in Canada, with the intent of building out a publicly traded CBD company, two employees soon after filed lawsuits over alleged contract breaches.

The suit involves disputes over percentages of ownership, verbal agreements and other matters.

There are at least a handful of other similar suits in Colorado, and Lamb believes more may come.

However, according to Dominque Mendiola, deputy director of the Colorado Marijuana Enforcement Division, which is part of the Colorado Department of Revenue, the main intent of HB 1090 was to clear some of the red tape for large corporations to have an interest in Colorado businesses.

“What we understood to be the focus in HB 1090 was to expand opportunity for investment in ownership of marijuana businesses in Colorado,” she said.

The law would enable businesses, as well as employees, to have small investments in Colorado firms, she explained.

Mendiola, who said the division has yet to see what she’d call an abundance of lawsuits or complaints over employee equity in cannabis firms, believes it’s too soon to tell if the new law will have the intended effects of bringing in more outside investors to the state’s cannabis industry.

If the law does work as intended, and more investors do start to take interest in Colorado cannabis businesses, more conflict could arise.

“There’s a lot of outside investors come in and they ask who owns this company, and sometimes that’s not a clear answer,” Lamb said.

Lamb recently worked with a Colorado company that was sold for a large sum of money to a big Canadian cannabis conglomerate.

After the company, which Lamb declined to name, was sold, current employees were given stock in the Canadian company.

“Everyone that has ever worked at this Colorado company said, ‘Hey, wait a minute, I used to work there, and when I worked there, I was promised some form of equity,’” she said. “I had a flood of ex-employees that all came forward when they heard the company was sold, all of them saying, ‘I get a piece of the sale.’”

She helped the company avoid litigation with six months of “clean up” work in which she went one-by-one to former employees and requested documentation, including when the employees worked for the company, when they were promised equity, and how much.

A sticking point became the time period during which employees said they were promised the equity and how big the company was at that time.

A startup that’s slightly more than just an idea, for example, may have no assets.

“And you’re an employee on the ground floor and you have 10%,” she added. “What’s that worth?”

At that point, an employee’s equity is probably worth roughly $0.

Lamb was able to either convince employees that they weren’t owed anything, or those who were owed something got paid out, she said.

“When I was picking off each individual person, I had to figure out when did they show up, when did they leave, what document they signed, if any, how long they worked there, were they there long enough to vest,” she said. “It affects the terms of the deal.”

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Washington Commissioner Asks Insurers to Extend Coverage to Delivery Drivers’ Personal Vehicles

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Washington Insurance Commissioner Mike Kreidler is asking insurers doing business in the state to immediately extend automobile insurance coverage for personal delivery drivers to aid people temporarily assigned this duty during the COVID-19 pandemic.

Kreidler said his office would expedite review and approval of the endorsement filings so that affected delivery drivers can have coverage quickly. He is notifying insurers of this recommendation today.

“Many businesses are going above and beyond to help people get prescriptions, groceries and food during this difficult and unprecedented time,” Kreidler said in a statement. “I urge insurance companies to immediately do all they can to help delivery drivers in their time of need. This will also help Washingtonians follow the governor’s directive to stay home and stay safe.”

Gov. Jay Inslee on March 23 ordered all Washington residents to stay home as much as possible to contain the spread of the coronavirus. In response to the public health emergency, many grocery stores, pharmacies and restaurants are offering delivery to people’s homes to meet the increased demand for supplies, prescriptions and food.

Normally, a personal auto insurance policy doesn’t cover the commercial use of a personal vehicle when acting as delivery driver.

Several insurers have already stepped up to help. They include: PEMCO; Liberty Mutual; and Allstate. State Farm has long provided personal coverage for drivers who deliver food or goods.

The endorsement would apply only to delivery drivers for retail and service operations during the pandemic and Washington state stay-home order. It doesn’t apply to people who drive for other commercial reasons, including rideshare or any commercial delivery businesses. The endorsement would remain in effect as long as the emergency order is in place.

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Demotech Affirms Ratings of 37 Florida Insurers; Still Reviewing Others

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Demotech has affirmed 37 of the 46 Florida-based companies rated by the actuarial firm, as of March 26, according to information gathered from Demotech’s website. That leaves fewer than 10 Florida insurers that are still awaiting a decision on their financial stability ratings (FSR) from the Ohio-based ratings agency.

Demotech said it is continuing to review both public and proprietary financial information and have discussions about business plans with the yet-to-be-affirmed insurers.

In mid-March, Demotech affirmed a slew of companies (see chart) and this week affirmed several others, including Capitol Preferred Insurance Co., Gulfstream P&C Insurance Co., and Security First Insurance Co.

The companies that are still in discussions and will either be affirmed or downgraded, as of March 26, include: Avatar Property & Casualty Insurance Co., Centauri Specialty Insurance Co., Cypress Property & Casualty, Omega Insurance Co., Safepoint Insurance Co., Tower Hill Select Insurance Co., and Tower Hill Signature Insurance Co.

The Florida Office of Insurance Regulation approved Tower Hill Select and Omega merging into Tower Hill Signature on March 25.

Demotech Actions

“Demotech has downgraded a number of carriers. Another subset of the carriers that we review and rate have opted to be purchased so that investors can exit the Florida residential property insurance marketplace. A larger number have been affirmed based upon (or in spite of?) their year-end operating results. Another group continues to dialogue with us and share their thoughts on the marketplace, how their business model must adapt, etc.,” Demotech President and Founder Joseph Petrelli said in a statement to Insurance Journal on March 25.

Companies that have not had their ratings affirmed as of press time are not necessarily being downgraded, and delays in ratings affirmations should not be misconstrued, according to Demotech. Many companies have avoided ratings downgrades by being acquired (see chart), or injecting significant capital into their books, while others have been able to sustain their rating by providing Demotech proprietary or confidential information that is not in the public domain, the company said.

Florida Insurers Financial Stability Rating (FSR)

  1. American Coastal
    A’; Affirmed 3/18/20
  2. American Integrity
    A; Affirmed 3/18/20
  3. American Platinum P&C
    A; Affirmed 3/18/20
  4. American Traditions
    A; Affirmed 3/18/20
  5. Anchor P&C Insurance Co.
    M – Downgraded 1/14/20; Ceased operations; Policies acquired by Homeowners Choice
  6. Avatar P&C
    A; Last Affirmed 12/13/19; Awaiting Update (Previously announced merger w/Centauri canceled)
  7. Bankers Insurance Co.
    A; Affirmed 3/18/20
  8. Capitol Preferred Insurance Co.
    A; Affirmed 3/23/20
  9. Castle Key Indemnity Co.
    A’; Affirmed 3/18/20
  10. Castle Key Insurance Co.
    A’; Affirmed 3/18/20
  11. Centauri Specialty Insurance
    FSR Under Review 3/21/20
  12. Cypress P&C
    A; Affirmed 12/3/19; Awaiting Update
  13. Edison Insurance Co.
    A; Affirmed 3/18/20
  14. FedNat Insurance Co.
    A; Affirmed 3/18/20
  15. First Community Insurance
    A; Affirmed 3/18/20
  16. First Protective Insurance
    A; Affirmed 3/18/20
  17. Florida Family Home
    A’; Affirmed 3/18/20
  18. Florida Family Insurance
    A’; Affirmed 3/18/20
  19. Florida Peninsula Insurance
    A; Affirmed 3/18/20
  20. Frontline Insurance Unlimited
    A; Affirmed 3/18/20
  21. Gulfstream P&C Insurance Co.
    A; Affirmed 3/23/20
  22. Heritage P&C Insurance Co.
    A; Affirmed 3/18/20
  23. Homeowners Choice P&C
    A; Affirmed 3/18/20
  24. Maison Insurance Co.
    A; Affirmed 3/18/20
  25. Monarch National Insurance
    A; Affirmed 3/18/20
  26. Olympus Insurance Co.
    A; Affirmed 3/18/20
  27. Omega Insurance Co.
    Being Acquired by Tower Hill Signature Insurance
  28. People’s Trust Insurance
    A; Affirmed 3/18/20
  29. Prepared Insurance
    Being Acquired by Lighthouse Property Insurance Corp.
  30. Safe Harbor Insurance Co.
    A’; Affirmed 3/18/20
  31. Safepoint Insurance Co.
    A; Last Affirmed 12/4/19; Awaiting Update
  32. Security First Insurance Co.
    A; Affirmed 3/18/20
  33. Southern Oak Insurance Co.
    A; Affirmed 3/18/20
  34. Stillwater Insurance Co.
    A; Affirmed 3/18/20
  35. Stillwater P&C Insurance Co.
    A; Affirmed 3/18/20
  36. St. Johns Insurance Co.
    A; Affirmed 3/18/20
  37. Tower Hill Preferred
    A; Affirmed 3/18/20
  38. Tower Hill Prime
    A; Affirmed 3/18/20
  39. Tower Hill Select
    Being Acquired by Tower Hill Signature Insurance
  40. Tower Hill Signature
    A; Last Affirmed 12/3/19; Awaiting Update
  41. TypTap
    A; Affirmed 3/18/20
  42. United P&C Insurance Co.
    A; Affirmed 3/18/20
  43. Universal Insurance Co. of North America
    A; Affirmed 3/18/20
  44. Universal P&C Insurance
    A; Affirmed 3/18/20
  45. US Coastal P&C
    A; Affirmed 3/18/20
  46. Weston Insurance Co.
    A; Affirmed 3/19/20

A” = Unsurpassed A’= Unsurpassed; A= Exceptional; S = Substantial; M = Moderate

In comments on its March 23 affirmation of Gulfstream P&C, Demotech Vice President Sharon M. Romano Petrelli said a delay in a rating affirmation should “not be made into something bigger than it is.” Gulfstream’s company business model kept them at the A level, despite increases in reinsurance costs anticipated in 2020 and litigation trends in the state. “The management team at Gulfstream has met or exceeded our financial metrics for the past several years,” she said.

Joseph Petrelli added that while Demotech reviews public information on all the carriers it reviews and rates, it also reviews holding company and affiliated entity financials when necessary.

“Gulfstream invited us to do so to better understand how they had positioned themselves to address the myriad issues facing the residential property insurance markets in Florida,” Petrelli said. “Given the breadth and scope of their capability to honor their commitment to policyholders, we needed additional time to digest their additional information.”

For Security First, which was affirmed on March 24, Petrelli said succession planning, managing claim litigation in a difficult judicial environment, and astute reinsurance purchasing are “three facets of the company’s enterprise risk management program that support” sustaining an FSR at the A level, “despite the projected increases in reinsurance costs anticipated in the near future.”

Demotech did not release a statement on the ratings affirmation of Capitol Preferred, which has a 36.5% rate increase request still under consideration by the Florida Office of Insurance Regulation. The company’s CEO told regulators at a rate hearing in February that the company needed the increase because of reinsurance costs, assignment of benefits (AOB) abuse and first party lawsuits.

January Warning

These long-awaited ratings announcements follow Demotech’s warning in January that it may downgrade as many as 18 of the 46 Florida domestic insurers it rates.

In a letter to Florida’s Citizens Property Insurance President and CEO Barry Gilway that was obtained by Insurance Journal, Petrelli outlined several factors in the state that were placing insurer ratings in jeopardy, including abuse of assignment of benefits agreements and first party litigation.

“The economics of the marketplace over the past several years have made it impossible for Demotech to sustain each of the Florida focused carriers that we review each quarter at a [FSR] of A, Exceptional,” he said.

Petrelli said that after Demotech reviewed the third quarter 2019 financials of carriers, it requested year-end projections of operating results for nearly half of the 40-plus carriers it reviews and rates.

“Having provided these carriers with ample time to implement revised business models, secure capital infusions, implement rate revisions, re-underwrite established books of business and utilize other enterprise risk management activities, it is apparent that few have returned to profitability,” Petrelli wrote.

Since then, several Florida companies have made moves. Anchor P&C ceased its operations and sold its policies to Homeowners Choice Insurance. Prepared Insurance was acquired by Lighthouse Property Insurance Corp. This week, the state approved the merger of the two Tower Hill companies.

Demotech would not disclose the names of the insurers it is still reviewing, but Petrelli said he expects it will announce several downgrades at the end of March. Petrelli told Insurance Journal this week that Demotech is in the process of having “thoughtful and focused” discussions with the management of the insurers not yet affirmed.

“If we are convinced that their action has addressed previous matters brought to their attention, and will facilitate their operational effectiveness in the ever-changing circumstances of the most difficult operating environment in the US, and provide them with the opportunity to make a reasonable profit, we sustain the Financial Stability Rating,” he said.

He also noted that some downgrades from ‘A’ FSR (Exceptional) to S (Substantial) are as much a reflection on the operating environment in Florida as they are on a carrier.

“It is the marketplace more than carrier-specific metrics that is driving the need for downgrades. If these carriers were focused on any other jurisdiction, they would be sitting in the driver’s seat,” he said.

Petrelli added that carriers that have sustained their ratings to date have shown Demotech “how they intend to fulfill their commitment to Floridians through their business model.”

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About Amy O’Connor

O’Connor is the Southeast editor for Insurance Journal and associate editor of MyNewMarkets.com. More from Amy O’Connor

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Restaurateur Sues The Hartford, Seeking Coverage for Coronavirus Business Interruption

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A well-known California restaurateur has filed a lawsuit against a unit of The Hartford, seeking a declaration that the owner’s commercial insurance policy covers losses caused by a statewide business shutdown ordered to prevent the spread of coronavirus.

The lawsuit, filed Wednesday by the owner of the French Laundry and the Bouchon Bistro in the Napa Valley community of Yountville, follows a similar suit by the Oceana Grill in New Orleans against a Lloyd’s of London insurer. Both actions challenge an argument by insurance defense attorneys that business interruptions in reaction to the coronavirus are not covered losses under most business insurance policies.

As it happens, the same attorney who filed the Oceana Grill lawsuit — John Houghtaling II of Metairie, Louisiana — is assisting with the California lawsuit.

“To avoid payments for a civil authority shut down the insurance industry is pushing out deceptive propaganda that the virus does not cause a dangerous condition to property,” Houghtaling said in a press release. “This is a lie, it’s untrue factually and legally.”

French Laundry and Bouchon Bistro are both owned by Thomas Keller, whom Houghtaling said is the only chef to have been awarded simultaneous three-star ratings by Michelin guides for two different restaurants.

Keller’s lawsuit says his policy with The Hartford Fire Insurance Co. does not have an exclusion for a viral pandemic. In fact, a “Property Choice Deluxe Form” in the policy extends coverage for a loss or damage due to virus. The suit says Keller’s KRM Inc. had to furlough 300 employees after shutting down the restaurants because of an order issued by the Napa County public health officer on March 18 allows take-out and delivery only.

The suit asks the Napa County Superior Court to declare that the order constitutes a prohibition of access to the restaurants and that it triggers coverage under the insurance policy.

A Native American tribe on Tuesday sued a group of insurance companies, asking a court to declare that losses it is incurring from shutting down its casinos during the coronavirus pandemic are covered by insurance. Among the defendants named in the lawsuit filed by the Chickasaw Nation in Oklahoma state court are several underwriters for insurance marketplace Lloyd’s of London, a unit of American International Group Inc. and XL Insurance America, now part of AXA SA.

Houghtaling said in a press release that restaurants across the United States are struggling because of the coronavirus.

“This entire sector is crippled by a nationwide public health shutdown impacting countless livelihoods,” he said. “We need insurance companies to do the right thing and save millions of jobs.”

Houghtaling said his first lawsuit in Louisiana was triggered in part by a March 12 article written by Shannon O’Malley, a partner with Zelle law firm in Dallas. She wrote that insurance policies that cover business-interruption expenses generally require a physical loss to trigger coverage, and that physical loss can’t be based merely on a supposition that coronavirus might be present.

She said even coverage that applies specifically to orders by civil authorities is contingent on actual physical property damage, not just the fear of contagion. O’Malley said: “unless the insured can prove that an order of civil authority was directly due to property damage at or near the insured’s location, the policy’s civil authority provision should not apply.”

The Hartford had no comment on the lawsuit. The property/casualty insurance industry has been mostly united behind the defense that most business interruption policies exclude coverage for pandemics and require physical damage to occur on the site.

Sean Kevelighan, president and CEO of the Insurance Information Institute (III), told regulators recently that while there is now pressure for insurers to cover business interruption resulting from a pandemic, insurers have investigated and modeled pandemic scenarios as they do other catastrophes and found it is not feasible to underwrite the risk in a way policyholders would be able to buy.

“It is important to appreciate that as much as this is a catastrophe of historic magnitude, there are more on the horizon—hurricanes, wildfires, floods—and we must remain prepared in the way that we have long-planned, so again, we can continue act as the financial first responder that we have been for several centuries,” Kevelighan stated.

David Sampson, president and CEO of the American Property Casualty insurers, said that it is important to defeat efforts to “imposed retroactive coverage.” He stressed that the current surplus funds and loss reserves of the industry are there to pay claims under policies as they have been underwritten and not to pay claims not anticipated. Sampson said business interruption issues are at such a scale in this pandemic that a federal solution is needed.

“I’m sorry to tell you up front, but the short simple answer is, no, there is no coverage. The longer answer is a bit more complicated, even though the ultimate answer is the same – no coverage,” wrote Christopher Boggs, in his Big I Insights blog this week, writing for insurance agents whom he said are being asked regularly by their clients if there is coverage. Boggs is executive director, Big I Virtual University of the Independent Insurance Agents and Brokers of America.

About the photo: The French Laundry restaurant in Yountville, Calif. Photo courtesy of Thomas Keller Group.

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